Firm-level shocks and labor adjustments

We analyze how firms adjust their labor in response to idiosyncratic shifts in their production function and demand curves using a unique data-set of Swedish manufacturing firms. We show that permanent shocks to firm-level demand is a main driving force behind both job and worker reallocation. In contrast, shocks to physical productivity and temporary demand shocks have a very limited impact on firm-level employment despite being important determinants of other firm-level fundamentals. We also present evidence suggesting that the adjustment to permanent demand shocks is fairly unconstrained. Most notably, firms primarily downsize through increased separations of both short- and long-tenured workers even when they could have adjusted their employment through reduced hires.